AS | Ankit Sarawagi|Founder, CFOmatrix·June 2026·11 min read | Updated Jun 2026 |
- Investors hold Preference Shares (CCPS), not equity shares. The CCPS is the wrapper that carries the liquidation preference, dividend rights, and anti-dilution until it converts.
- “Compulsorily Convertible” is a FEMA requirement for foreign investors: a CCPS counts as equity, not debt, so it must convert and can never be redeemed for cash like a loan.
- The conversion ratio starts at 1:1 but can move above 1:1 through anti-dilution, handing the investor more equity shares than they “paid for.”
- Cumulative dividends pile up year after year and must be cleared before equity shareholders see a rupee on exit. Non-cumulative dividends do not.
- Pay-to-play forces investors to keep funding or lose their preferred rights. It can actually protect founders in a tough round.
| 1:1 The default conversion ratio: each preference share (CCPS) becomes one equity share, until anti-dilution moves it | ₹6 crore A 6% cumulative dividend on the ₹20 crore Series A, accrued and waiting to be cleared after 5 years before founders see a rupee | 0 Rupees a CCPS investor can demand as redemption: compulsorily convertible means it must turn into equity, never be repaid like debt |
Every scenario below uses this cap table. The Series A round set the company’s post-money valuation at ₹100 crore. Founders and the ESOP pool hold equity shares; the two investors hold preference shares (in India, almost always CCPS), which is what carries every economic right in this post.
| Shareholder | Holding | Share Type | Capital Invested |
|---|---|---|---|
| Founder A (CEO) | 30% | Equity Shares | Nil |
| Founder B (CTO) | 22% | Equity Shares | Nil |
| Founder C (COO) | 8% | Equity Shares | Nil |
| Angels & ESOP pool | 5% | Equity Shares | Nil |
| Seed Investor | 15% | Preference (CCPS) | ₹6 crore |
| Series A Investor (lead) | 20% | Preference (CCPS) | ₹20 crore |
What Preference Shares Are
Plain definition: A preference share is a share that gets treated preferentially over ordinary equity shares on two things: getting paid on an exit or winding-up, and getting a dividend. The holder gives up some of the “owner” feel of a plain equity share (often less voting on routine matters) in return for being first in the queue for money.
Why it’s in the agreement: Investors want the upside of equity but a cushion on the downside. A preference share is that compromise. It lets the Series A Investor say, on a bad exit, “pay me my ₹20 crore back before the founders take anything,” while still letting them convert and ride the upside on a good exit. Founders hold ordinary equity shares; investors hold preference shares, and that distinction drives almost everything in an Indian SHA.
The same percentage, very different rights
The Series A Investor owns 20% and so do nothing-special equity shareholders in a textbook. But because the Series A holds preference shares, that 20% comes bundled with a liquidation preference, a dividend right, anti-dilution, and conversion mechanics. Founder A’s 30% in equity shares carries none of these. Two lines on the same cap table, two very different instruments.
Preference is a wrapper, not one right
It helps to read “preference shares” as a container. Inside it sit the economic rights we cover here (conversion, dividends, pay-to-play) plus the liquidation preference and anti-dilution covered in their own posts. When founders say “the investor has preference shares,” what they really mean is “the investor has a bundle of rights my equity shares do not.”
Indian companies can issue redeemable preference shares (which the company buys back for cash) or convertible ones (which turn into equity shares). Startup investors almost always take the convertible kind, and for foreign money it must be compulsorily convertible. That is the CCPS, and it is the subject of the next section.
Why CCPS: the FEMA Angle Every Founder Should Know
Plain definition: CCPS stands for Compulsorily Convertible Preference Shares. They are preference shares that must convert into equity shares at or before a fixed date or event (often the next priced round, an IPO, or a long-stop date). “Compulsorily” is the key word: conversion is not the investor’s option, it is mandatory.
Why it’s in the agreement: Two reasons stack up. First, investors get to enjoy preference economics (liquidation preference, dividend, anti-dilution) while they wait, then convert to equity to ride the upside. Second, and this is the Indian moat, FEMA treats a compulsorily convertible instrument as equity, not debt. A foreign investor putting money into an Indian company through ordinary or optionally convertible preference shares risks the investment being classed as external commercial borrowing (a loan), which is heavily restricted. A CCPS sidesteps that: because it must convert, it counts as foreign direct investment in equity.
The foreign Series A Investor
Say the Series A Investor (₹20 crore for 20%) is a fund based in Singapore. They cannot simply lend the company ₹20 crore and call it equity, and they cannot take a preference share that the company could redeem for cash later, because under FEMA that looks like debt. So they take CCPS: ₹20 crore of compulsorily convertible preference shares that will turn into 20% equity. FEMA is satisfied, the investor gets preference protection in the meantime, and the founders get clean foreign capital.
No redemption, only conversion
Because the CCPS is compulsorily convertible, the Series A Investor can never knock on the door and demand their ₹20 crore back as a buyback of the preference shares. The instrument must become equity. If they want liquidity, they have to use other clauses, exit rights such as buyback of equity, put options, or a drag on a sale, which live elsewhere in the SHA. The CCPS itself is a one-way street into equity.
FEMA also requires that the conversion price or formula be fixed up front, at the time the CCPS is issued, for foreign investors. You cannot leave it open to be decided later. If your term sheet has a foreign investor and a vague conversion formula, your lawyer must pin down a FEMA-compliant pricing method before closing, or the round can stall at the bank.
Conversion Rights & the Conversion Ratio
Plain definition: The conversion ratio is how many equity shares each preference share turns into when it converts. It usually starts at 1:1: one CCPS becomes one equity share. Conversion rights cover when and how that happens, automatically on certain events (an IPO, the next priced round) or voluntarily if the investor chooses.
Why it’s in the agreement: The ratio is the dial that decides how much equity the investor ends up with. A 1:1 ratio keeps things simple. But the ratio is also the machinery that anti-dilution uses: if the company raises a down round, the conversion ratio is adjusted upwards so each preference share converts into more equity shares, protecting the investor from the lower price.
The clean 1:1 conversion
The Series A Investor holds CCPS that map to 20% of the company. At a clean conversion (say, an IPO), each CCPS becomes one equity share at 1:1, and the Series A simply holds 20% in equity shares. Nothing moves on the cap table. This is the base case, and it is what you want.
A down round pushes the ratio above 1:1
Now suppose the company raises a Series B at a lower price than the Series A paid (a down round). The Series A Investor’s CCPS carries weighted-average anti-dilution, which adjusts the conversion ratio to, say, 1:1.25. Each CCPS now converts into 1.25 equity shares. The Series A’s effective stake climbs from 20% towards roughly 24% to 25%, and that extra equity comes out of the founders’ and ESOP holders’ percentages. The ratio is where anti-dilution quietly does its damage.
Say the Series A holds 2,00,000 CCPS mapped to 20%. At 1:1 they convert to 2,00,000 equity shares. After a down round triggers a 1:1.25 ratio, the same CCPS convert to 2,50,000 equity shares, an extra 50,000 shares the founders never sold.
The investor paid for one block of preference shares but walks away with a quarter more equity. That is the conversion ratio and anti-dilution working as one machine.
Read the conversion clause and the anti-dilution clause together; they are the same lever. A “1:1 CCPS” is harmless on its own, but if it is attached to full ratchet anti-dilution, a single down round can swing the ratio hard against you. Always ask: what events change the ratio, and by how much? Model the worst case before signing.
Dividend Rights: the Preferred Coupon
Plain definition: A dividend right on preference shares gives the investor a fixed dividend (say 0.001% as a token, or a real coupon like 6% to 8% a year) that ranks ahead of any dividend to equity shareholders. The preference dividend must be satisfied before founders get a rupee of dividend.
Why it’s in the agreement: In India, the Companies Act requires preference shares to carry a preferential dividend, so almost every CCPS names a dividend rate. Often it is a nominal 0.001% just to tick the legal box. But when an investor wants a real return floor, they negotiate a meaningful rate, and that is where founders need to pay attention, especially if it is cumulative (the next section).
The token dividend
The Series A CCPS carries a 0.001% dividend on ₹20 crore: about ₹20,000 a year. It exists only to satisfy the law that preference shares carry a preference dividend. It is economically irrelevant, and most clean Indian early-stage rounds use exactly this. The founders barely notice it.
The real coupon
Now suppose the Series A negotiates an 8% dividend on their ₹20 crore: that is ₹1.6 crore a year ranking ahead of any equity dividend. A startup reinvesting every rupee will not actually pay this out in cash, so in practice it does nothing year to year. The sting only appears if it is cumulative, because then it silently builds up and gets clawed back on exit. Whether the dividend matters comes down to one word, covered next.
A preference dividend almost never gets paid in cash at a growing startup, because there are no profits to distribute and no founder wants to send cash out the door. So the dividend rate looks harmless. The question is not “will we pay this dividend?” (you won’t) but “does it accrue and get added to what the investor takes out on exit?” That is the only version that costs founders real money.
Cumulative vs Non-Cumulative: the One-Word Difference That Costs Crores
This is the dividend distinction founders mix up most, and it is a single word in the term sheet.
Non-cumulative is use-it-or-lose-it: if the company does not declare the dividend in a given year, the investor loses it for that year, gone. Cumulative means the dividend accrues every year whether or not it is paid, and the entire unpaid pile must be cleared before equity shareholders receive anything on an exit or winding-up.
The Series A has an 8% cumulative dividend on ₹20 crore. The company never declared it, so after 5 years it has piled up to roughly 5 × ₹1.6 crore = ₹8 crore. On exit, the Series A takes their ₹20 crore liquidation preference plus the ₹8 crore of accrued dividend off the top: ₹28 crore before founders see a rupee.
Had it been non-cumulative, those five undeclared years would simply be gone, and the investor would take only their ₹20 crore. The single word “cumulative” added ₹8 crore to the investor’s exit.
| Non-Cumulative | Cumulative | |
|---|---|---|
| If a year’s dividend is not paid | It is lost forever | It accrues and carries forward |
| Effect over time | Stays flat | Grows the investor’s exit take |
| On exit (8% on ₹20 cr, 5 yrs) | Investor takes ₹20 cr | Investor takes ₹28 cr |
| Friendlier to | The founder | The investor |
Cumulative = it accumulates. The unpaid dividends pile up like a tab the company has to settle on exit. Non-cumulative = no carry-over, each year resets to zero. Push for non-cumulative, or for a token rate, so there is no tab to settle.
A high dividend rate paired with the word “cumulative” is a liquidation preference in disguise: it grows the investor’s guaranteed exit take every year you do not exit. If you cannot kill the accrual, fight for a token 0.001% rate so the pile-up is meaningless, or cap the accrual at a fixed number of years.
Pay-to-Play: Keep Funding, or Lose Your Rights
Plain definition: A pay-to-play provision says an existing investor must put in their pro-rata share of a future round, or they are penalised, usually by having their preference shares (CCPS) forcibly converted into ordinary equity shares, stripping away their liquidation preference, anti-dilution, and sometimes their board and veto rights.
Why it’s in the agreement: It is one of the few investor clauses that can actually help founders. Pay-to-play stops a passive investor from sitting on rich preferred rights while refusing to support the company when it needs more capital. It rewards investors who keep backing you and punishes those who go quiet. It most often appears in a hard or down round, where the company badly needs everyone to re-up.
The Seed Investor refuses to re-up
The company raises a tough Series B and needs existing investors to support it. Under pay-to-play, both the Seed and Series A Investors must invest their pro-rata share. The Series A invests their portion and keeps their CCPS and all preferred rights. The Seed Investor declines. As a penalty, the Seed Investor’s 15% in CCPS is converted to ordinary equity shares: they lose their liquidation preference and anti-dilution and become a plain equity shareholder, just like the founders.
Why this is good news for founders
On a later bad exit, the Seed Investor (now plain equity) no longer takes a ₹6 crore preference off the top. That ₹6 crore stays in the pool for everyone, including the founders. Pay-to-play shrank the preference stack the founders have to clear, simply because one investor stopped playing. It also pressures every investor to keep funding the company in a crunch, which is exactly when founders need them most.
Pay-to-play helps founders, so a sharp lead investor may resist it or carve themselves out of it. Read who it actually applies to. Also check the penalty: forced conversion to equity shares is the standard, but some versions only strip anti-dilution or cut the investor down to a smaller class. The harder the penalty, the stronger the pressure to keep funding, which is usually what you want as a founder.
How the Economic Rights Fire Together
These terms are not separate trivia; they sit inside one CCPS and resolve in a fixed sequence across the life of an investment. Here is the order they actually play out in:
1 | The investor takes CCPS Money comes in as compulsorily convertible preference shares (FEMA-friendly for foreign capital), carrying a conversion ratio and a dividend rate. |
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2 | The dividend accrues (or not) Year by year, a cumulative dividend silently piles up; a non-cumulative or token one does not. This sets how much extra waits at exit. |
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3 | A new round tests pay-to-play and the ratio If it is a down round, anti-dilution moves the conversion ratio; if there is pay-to-play, investors who do not re-up lose their preferred rights. |
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4 | Conversion settles the final equity At an IPO or sale, each surviving CCPS converts at its (possibly adjusted) ratio into equity shares, and any accrued cumulative dividend is cleared first. |
“The investor’s percentage is the headline. The CCPS terms underneath it, conversion ratio, dividend, pay-to-play, are the fine print that decides what that percentage is really worth.”
Ankit Sarawagi, CFOmatrixFrequently Asked Questions
Why do Indian startups use CCPS instead of ordinary preference shares?
Because CCPS keep everyone happy. Investors get preference economics (a liquidation preference, dividend rights) while they wait, and under FEMA a compulsorily convertible instrument is treated as equity for foreign investment, so an overseas investor can use it without it being classed as external debt. They must convert into equity shares; they cannot stay as preference forever or be redeemed for cash like a loan.
What is a conversion ratio and when does it change?
The conversion ratio is how many equity shares each preference share turns into. It usually starts at 1:1, so one CCPS becomes one equity share. It changes when anti-dilution protection or a stock split kicks in. If the company raises a down round, anti-dilution can push the ratio above 1:1, so each preference share converts into more equity shares and the investor ends up with a larger stake.
What is the difference between cumulative and non-cumulative dividends?
A non-cumulative dividend is use-it-or-lose-it: if the company does not declare it in a year, it is gone. A cumulative dividend accrues year after year whether or not it is paid, and the whole unpaid pile must be cleared before equity shareholders get anything on an exit. Cumulative dividends quietly grow the investor’s effective preference over time.
What does pay-to-play mean in a term sheet?
Pay-to-play says an existing investor must keep investing their pro-rata share in future rounds, or lose some of their preferred rights. Typically their preference shares convert to ordinary equity shares (and they lose anti-dilution, liquidation preference, and sometimes board rights). It rewards investors who keep backing the company and penalises those who stop, which can actually help founders in a tough round.
Do founders get the dividends on preference shares?
No. Preference share dividends are paid to the investors who hold the preference shares, and they rank ahead of any dividend to equity shareholders. Founders hold equity shares, so they only receive a dividend after the preference dividend is satisfied, which in practice almost never happens at an early-stage startup that reinvests every rupee.
Can a CCPS investor force the company to buy back their shares?
Not through redemption. A compulsorily convertible instrument must convert to equity, it cannot be redeemed for cash like a redeemable preference share or a loan, which is exactly what FEMA requires for foreign investors. Investors instead get liquidity through exit rights such as buyback, put options, or a drag on a sale, which are separate clauses in the SHA.
This is a general explanation for founders, not legal advice. Indian deals involve specific structures (CCPS, FEMA rules on share pricing and conversion, and the way preference terms are drafted into the Articles of Association). Have your term sheet and SHA reviewed by a lawyer before signing.
- SHA, SSA & Term Sheet Explained: The Complete Guide for Indian Founders Investment Agreements · Pillar
- Liquidation Preference: 1x, Participating vs Non-Participating & Multiples Investment Agreements · SHA Series
- Anti-Dilution Explained: Full Ratchet vs Weighted Average Investment Agreements · SHA Series
AS | Founder, CFOmatrix | Finance Strategy & Equity Compliance CFOmatrix is a knowledge platform focused on how finance actually works inside growing companies. Every insight is shaped by real operating experience across startups and growth-stage companies, including cross-border setups. |